Five Trusts You Do (or Maybe Don’t) Need

We get asked a lot about Trusts, so here’s some gospel. There is no single do-it-all, one-size-fits-all Trust. Each is perfect for some situations, perfectly awful for others. A book about trusts in our library is 855 pages long, and that’s not enough to cover all the types, so the book comes with a CD of trust material, too.

Anyway, here’s the quick guide to the most common ones – and a generic snapshot of why each might or might not be right for you.

The Revocable Trust / The Living Trust.
Revocable Trusts – synonymous with “Living Trusts” — leave you alone while you’re alive and well. Everything in this Trust is all for you.

So why bother with this Trust? If you become incompetent, this Trust’s benefit kicks in: someone automatically takes over running the trust, continuing it seamlessly for your benefit. These trusts don’t cause any additional income tax or estate tax.

And if you’re caring – or going to care – for a loved one, Revocable Trusts are much better and much safer than joint accounts.

Regardless of mental prowess, Revocable Trusts also work great if you own property in another state and don’t want your executor to be hog-tied by that other state’s laws when you go to sell it.

But caution: a Revocable Trust is not a panacea. If you live in Georgia, using one to beat probate is generally a waste of money. And if you’re looking to protect assets, look elsewhere; assets in a Revocable Trust can be reached by a creditor as it wasn’t there.

Finally, a Revocable Trust will only work on the assets placed in it. There’s no tax effect to putting things in the Trust’s name. But you’ve got to do it or the trust is like an empty grocery bag.

The Credit Sheltered Trust.
This is sometimes called the “Bypass Trust” or part of the “A-B Trust,” or the “Residuary Trust.” Under current law, this type of Trust can make $5 million+ free of all estate taxes.

But what if your assets aren’t close to the $5 million+ mark? Then directing assets automatically into one of these Trusts for your spouse is probably a waste of paper, and one that could make your spouse have to answer to a trustee or co-trustees.

So if you haven’t looked at your (or your parents’) documents lately, you’ll probably find a Credit Sheltered Trust in them. They were “automatics” in estate plans for decades – up ‘til 2005 or so.

Nowadays, except for particular situations, this kind of trust is equivalent to a VHS tape; it works but who needs it? And so why saddle (or be saddled) by a Credit Sheltered Trust, if the assets aren’t there?

The “Marital” or “QTIP” Trust.
This Trust is a way to give your spouse income for life, but prevent his or her kids from getting anything when that spouse dies. The Trust holds assets, and gives your spouse income for life. Maybe more. And then when the spouse dies, the assets remaining in this Trust can go whomever you direct . . . even giving you the income for the rest of your life.

The Irrevocable Trust.
An Irrevocable Trust should start with a big CAUTION sign. It works great with the right asset, such as a life insurance policy (more on this below). But drop an otherwise-innocuous asset – how about some appreciated stock? — into an Irrevocable Trust and you’re transported into a tax minefield: immediate capital gains, income taxes at the highest rates, and other problems you didn’t even think to worry about.

So while Irrevocable Trusts are useful, beware the minefield around each one. Creating one is definitely not a do-it-yourself project.

What’s different about an Irrevocable Insurance Trust?
Put an insurance policy in the right kind of Irrevocable Trust, and you end up with some great benefits. Why bother? When you die, this Trust can keep a taxable estate from being created, or if there’s going to be one, it can keep the insurance from being taxed. (Translation: if you and your spouse have 3 million in assets, that’s not taxable; but if you had another $3 million in insurance, that would be.) Why? The insurance policy you own is in the pile when your assets are added up for estate tax purposes. If you cross the tax threshold, you can assume that the 40% estate tax rate will apply to what’s in there.

This really gets to an Emperor’s-New-Clothes issue: why do you need to be the formal owner of a life insurance policy on your life? When you’re dead, you’re dead, right? Keep the policy out of your estate. Have a trustee of an Irrevocable Insurance Trust be the owner.

Having an Irrevocable Life Insurance Trust gives you creditor benefits, too, by the way.

The “I’m-the-Beneficiary-and-I’m-the-Trustee-and-Nobody-Can-Touch-My-Assets” Trust.
Basically, this Trust doesn’t exist and it won’t work. Here’s the mantra to remember: “A creditor with a judgment against me can do everything I can do.” Translation; if you have the power to dip into trust assets, or revoke a trust, or amend a trust, or anything else, so can your creditor.”

Other Trusts. What’s above is the tip of a documentary iceberg. There are charitable trusts, special needs trusts, discretionary trusts, and plenty more. What’s above are just general information about the ones we’re asked about most often.